In connection with the Department of Labor’s new regulations, a new term has entered our lexicon: “proprietary product.” These products are subject to a variety of restrictions and disclosure requirements, which we discussed in our prior issue of this publication.
In the structured products area, market participants are quite accustomed to the word “proprietary” in connection with so-called “proprietary indices.” In that context, this term is not a legal term, and is not defined by any statute or regulation. However, typically, it refers to an index developed by a financial institution in order to reflect the results of a particular investment strategy and/or to track specific types of assets.
Under the new Department of Labor regulations, a “proprietary product,” refers to a financial product that is “managed, issued or sponsored” by the financial institution or one of its affiliates. (The initially proposed rule used a somewhat narrower definition, requiring that a product be “managed” by the financial institution or an affiliate.) Accordingly, we now have a U.S. regulation that creates a new legal term.
The problem: in many cases, there is uncertainty as to how this definition should apply to many or most structured products. The terminology used in the definition is hard to apply to an unsecured debt security, which is the “wrapper” for most structured notes.
“Issued.” We’re pretty sure we understand what it means for a structured product to be “issued” by a financial institution or an affiliate. So, we’ll leave that one alone here.
“Managed.” In the case of an unsecured debt security, we would like to think that this term is inapplicable. “Management” sounds like a term from the investment company regime, where a fund manager “manages” the investments held by the entity.
On the other hand, to the extent that an underwriter “manages” the distribution, makes a secondary market and provides pricing information, or determines the payments on the notes in its capacity as a calculation agent, does that render a product “managed” and, therefore, “proprietary”? We’d like to think that the answer is “no,” and that is not what the new rules are attempting to reach.
“Sponsored.” This is another term that seems to emanate from the investment company world, and shouldn’t be applicable to structured notes. However, under a very broad use of the term, perhaps “sponsor” is broad enough to pick up creating the terms of an instrument, and marketing it? Again, we’d like to think that this is too broad a reading of the term.
During the next several months, industry participants are expected to seek guidance from the Department of Labor as to many definitional and substantive provisions of the new regulations. Questions will arise from virtually all segments of the securities markets. It is our hope that the issues raised by participants in the structured products market will be better understood as a result of these interactions.